My Life as a Quant: Reflections on Physics and Finance
Emanuel Derman
Wiley, 2004
Review score: **** out of *****

The label "Quant" is applied to specialists in quantitative finance. Quantitative finance is a relatively new area in finance that uses mathematics and computer based techniques to model financial markets or to find trading opportunities.

While working at Prediction Company I developed a strong interest in finance and quantitative techniques that continues to this day. When I saw Emanuel Derman's book on Amazon, I immediately ordered it. I expected a book like The Mind of Wall Street by Leon Levy: an interesting and informative read. I was not disappointed: I learned something about what it is like to work at a large Wall Street firm and about quantitative finance (in particular valuation of derivatives). But I also found a book which was very well written and engaging. My Life as a Quant was an unexpected pleasure.

My Life as a Quant recounts the evolution of Derman's life, from his youth in Cape Town, South Africa to the Wall Street firm Goldman Sachs where Derman spent most of seventeen years working in quantitative finance. The trajectory of Derman's life between these two points passed through the graduate Physics program at Columbia University and a decade in postgraduate theoretical particle physics.

Derman writes modestly about his abilities, but it is clear that from an early age he was brilliant. He entered the University of Cape Town at sixteen, finishing his undergraduate degree four years later. At the University of Cape Town Derman specializing in applied mathematics and physics. Like many talented young people in physics Derman dreamed of adding his name to the pantheon of physicists that includes giants like Newton, Einstein, Schrödinger, Feynman, Dyson and Bohr. South Africa was a scientific backwater and Derman applied to graduate programs in England and the United States. He was accepted by the Columbia University graduate physics program and left for New York City.

Physics is one of the most demanding academic disciplines and theoretical physics is the most demanding area within physics. At Columbia Derman found himself surrounded by brilliant graduate students. Derman was determined to pursue theoretical physics, but he found that before he could start on his thesis work he had to take two years of physics courses.

Derman's account of his seven years in graduate school, from which he finally emerged with a PhD in theoretical particle physics, is full of interesting portraits of his professors and other denizens of the physics world. Derman has an unusual talent for explaining technical issues in a clear non-technical fashion and he gives the reader an overview of particle physics and his thesis topic.

The perception that the US lagged the Soviet Union in science after the Soviet Sputnik launch produced a boom in the funding for the sciences and an expansion in University graduate programs. Many of these programs hired relatively young tenured professors. These professors had a long academic careers ahead of them, leaving few openings in University research groups for newly minted PhD's of Derman's generation (when he finished his PhD in 1973, Derman was part of the largest crop of graduate physicists that Columbia had produced up to that point). With few professorships available for new PhDs, this meant a series of two year post-graduate research fellowships. The hope was that during these fellowships a body of impressive publications could be amassed to gain one of the few tenure track professorships.

As we get older our hopes and dreams dim in the face of the slings and arrows of life. This is one of the most poignant parts of Derman's story. The dream of being another Einstein was slowly eroded by Derman's experience in physics until in the end he left the field entirely. Emanuel Derman is a brilliant man, but in the rarefied environment of theoretical physics he realized that he would not be another Feynman.

The series of post-doctoral fellowships eventually wore Derman down. Each fellowship involved settling into a new environment and attempting to do enough solid research to publish papers that would assure the next fellowship. Derman's first fellowship separated him from his wife, Eve, who was finishing her own PhD in biology. They were later united at Oxford when she finished her degree and it was there that they started a family. After Oxford, Derman won a third fellowship at Rockefeller University, back in New York. By the end of this fellowship and a year teaching physics at the University of Colorado, Derman was burned out by the academic struggle. Feeling a bit like Adam, driven from the paradise of pure research, Derman left the academic world for AT&T's Bell Labs.

My Life as a Quant is not a "confessional" autobiography. There is much about his inner life and experience that Derman keeps private. But he does give the reader a view of some of his inner struggles, both in his profession and in his search to find meaning and direction in his life.

Derman spent five years at Bell Labs at Murry Hill, New Jersey. Derman hated the layers upon layers of corporate hierarchy and the bureaucracy. But Murry Hill was also the home of the engineers and computer scientists who created UNIX (Pike, Kernighan, Ritchie, Aho and others). Derman worked down the hall from David Korn (creater of the UNIX Korn Shell) and was exposed to UNIX, as both an operating system and as a software development environment. It was at AT&T that Derman fell in love with software development.

After leaving Bell Labs, Derman joined the "Financial Stratagies Group" at Goldman, which dealt with fixed income instruments (treasury bills, corporate bonds and other corporate debt instruments). He learned options theory, as it applied to the valuation of fixed income instruments (options theory was originally developed for stock options). Eventually Derman pioneered several options valuation models that are now in wide spread use.

Wall Street companies provide some of the largest financial rewards available outside the rarefied levels of corporate executive suite. These rewards attract people like Emanuel Derman, who are some of the brightest people in the world (brilliance does not seem to be required of corporate executives). Derman was in the forefront of a wave of physicists who went to work on Wall Street. Like Derman, many of them left research and University life as jobs became more difficult to obtain.

On the surface there are similarities between physics (particularly statistical physics) and quantitative finance. For example, the book An Introduction to Econophysics: Correlations and Complexity in Finance (Mantegna and Stanley, Cambridge University Press, 2000) shows how some of the mathematics used in physics can be applied in finance.

Derman writes that early in his second career in quantitative finance he hoped to find the same sort of descriptive equations in finance that exist in physics. But markets are composed of large numbers of people who are capable of changing their behavior. Markets are complex systems, and the predictability that exists is limited. Although Derman made important contributions to options theory, he writes that models in finance always have limited power. Those who forget this, he points out, will pay for their hubris with financial loss.

The number of brilliant people attracted to Wall Street can be daunting. But Derman writes that models built by bright quants are just a part of what is needed to gain profits. At Goldman he spent more time building software systems than he did working on models. Software that helped traders do their work better and faster could be as important as a more accurate valuation model. As a software engineer who is bright, but not brilliant, this gave me some hope.

I have only had limited experience working in finance. During my brief adventure in finance I met some very brilliant people, but also some extremely dysfunctional people. These people treated those who worked for them poorly. This resulted in high staff turnover among a remarkably gifted group of people. I have wondered how representative my experience was of finance in general. From reading Derman's account, my experience was not unusual. He writes of a rather grim year he spent at Solomon Brothers, before returning to Goldman Sachs. Even at Goldman it appears that Derman developed a thick skin. He tells of traders and managers yelling at colleagues and subordinates.

The most successful people on Wall Street are able to amass large fortunes. However, people like John Merriweather (of the Solomon Brothers bond group and a founder of Long Term Capital Management) seem to find that they cannot leave Wall Street. At their level the money is only a way to determine whether they are winning more losing. Win or lose, they cannot seem to imagine a life where they are not "players".

Derman does not discuss his compensation at Goldman. I speculate that at a minimum he managed to put aside enough money to put his children through Ivy League schools. In the end, however, greed for more money and the draw of being a "player" had no hold on Derman. When he found something that would make him happier, he stepped away from Wall Street (although he did not leave it entirely).

Ian Kaplan
November 2004
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